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The history of business valuations

Though the exact dates about the inception of business evaluation are not documented, it is

believed that it began when the need to record and keep transactions arose. Originally an aspect

of accountancy, business evaluation was necessitated by the significance of business appraisal to

measure growth, opportunities, and the future of business. Thus, the history of business valuation

and accountancy are intertwined because it is a practice enabled and necessitated by accounting.

Since the beginning of business valuation, changes have occurred as influenced by the dynamics

of the business environment. In the UK, business valuation has been in existence since ancient

times as a significant aspect of accountancy. According to ICAEW in 1494, Luca Pacioli

invented the first double entry book for entry of transactions and keeping business records.

However, it was until 1553 that a book was published by James Peele on entry bookkeeping. In

the 18th century, the need for an effective accountancy approach was inevitable due to the

increase in the economic activities caused by the beginning of the industrial. Accounting to

ICAEW the earliest established and traditional professional accounts in the UK were based in

Bristol in the 1780s.

However, accounting had developed even before this era due to the need to keep the

business transactions records due to commercialization of production and the increase in trade. In

the 1840s, the need for business evaluation first arose due to corporate scandals and insolvencies.

As a remedy to the surge ins corporate scandals, audit and company evaluation was necessitated
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to resolve the winding up of companies and losses that occur due to corruption and failure to

forecast and identify the challenges of business early (ICAEW). The corporate scandals and

insolvencies also necessitated the enactment of laws to provide a legal framework for auditing

companies' valuation and accountability. In the 1870s, the need to establish a society of

accountants arose; this was to enhance the quality of accountancy, set standards aOn

professionalism. In 11 May 1880, a Royal Charter granted by Queen Victoria mandated the

creation of the national body of Accountants to standardize accounting and enhance

professionality and efficacy. The founder members of the national accountants’ body were 587.

The Royal Charter granted permanence to accounting in the UK and influenced enhanced

professionalism and standards of services offered by the accountants in that era. After the

creation of the national body of accountants, the election of the body’s president occurred

followed by the setting of professional standards of conduct of members.

Professional standards of conducts setting were an approach to regulate the actions of

accountants and to enhance their conduct were in tandem with the stipulations of the law. Also,

this was to ensure accounting served its primary objective; auditing, business valuation, and

accountability in record keeping. In the 1900s, technical roles of accounting were developed

such as accounting management, treasury and finance control, and corporate governance. In all

the stages of the development of accountancy, business valuation was an integral aspect of it.

However, it was until the complex needs of business valuation arose in the 1880s that business

valuations became prominent and more relevant (ICAEW). To date, there are specialties in

business valuation as a separate part of accountancy. The sum of the factors that necessitated the

development of business valuation was a better understanding of the company’s asset resale

value. Also, to avoid estimation and errors in the determination of the actual value of a business,
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both the public and private companies needed valuations. The competition in the business

environment due to the increase in trade and entry of many countries in the same industry led to

the emergence of mergers. As a result, a viable approach was needed to accurately estimate the

value of individual companies. Thus, business valuation became imperative to ensure the

accurate value of every company is measured before the merger to determine shares by all the

parties involved. The competition in the business environment also necessitated other models of

business that would create a competitive advantage. For instance, a business with investors

required a business valuation to attract investors. The information from valuation describes the

state of the company and whether it is viable for investment or not.

How the processes for business valuation for private companies were developed

The process of evaluating private companies conforms to the standard accountancy

procedures. The development of these procedures is based on the years of development and

growth of accountancy. For instance, in the UK, the process of evaluating private companies

dates back to the 1880s. In this era, accountancy was necessitated by the need to carry out an

audit and evaluate the value of companies to determine their economic status (ICAEW). The

process was also necessitated by the need to prevent corporate scandals insolvencies that violated

the investor's rights. Over the years, business valuation has become imperative especially in

preventing losses and also to forecast the future of a company. private companies also their

capital through different sources such as investors. Thus, business valuation is necessary to know

whether a business can attract customers or not.

Despite the different reasons for the valuation of companies, over the years, the process

has been based on a checklist to ensure the valuation conforms to the needs of the company. The

checklists involve an understanding of the valuation purpose to ensure it focuses on the primary
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goal. For instance, if a valuation is performed to inform a merger, the primary goal is the value

of an individual company because the information is imperative in determining operations. The

second step in the checklist is the determination of the value basis. The reason for conducting the

business value defines the aspect of the company to be evaluated for accuracy purposes. Thus, in

some instances, the value of the assets is imperative while this might not be valued in other cases

because it will not reflect the aspect of the company being evaluated or measured by the

valuation process. The third step is the valuation premise determination which is influenced by

the basis and purpose of the valuation. After that relevant data about the company is gathered

and analyzed based on the premise, purpose, and basis of the valuation. The next steps are the

business performance historic review and future outlook determination. All these steps

accumulate to determine the suitable valuation approach. However, before value determination, a

discount applies, especially to private companies.

The top three valuation methods used today

The professionals and experts in business valuation mainly use three approaches in

determining the business value; the market, income, and asset approach. The market approach to

business valuation is mainly based on the establishment of business value by comparing sales of

businesses of interest with subject business. The method works best when the numbers of similar

comparable businesses are available. For instance, professionals employ the method in valuing

non-private companies because data of comparable non-private businesses are readily available

(Trugman). Under the market approach, the experts select current transactions involving the

comparable businesses and establish pricing multiples through methods such as guideline public

company and merger and acquisition. For guideline company, market price of particular

comparable stocks are considered from the public company whose price is then developed
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through finding a quotient between stock price and variable. For the merger and acquisition

method, the price multiples are calculated based on real-world transactions including operating

units that have already been sold. The price multiple is then applicable to the subject business's

variables.

The income approach method of business evaluation involves the conversion of future

expected cash flow benefits into a present value. Given that the approach determines business

value based on its capability to realize future cashflows, it is suitable for already developed and

profitable businesses. The income approach can broadly be evaluated by the capitalization of

earning method and discounted cash flow (DCF) method. The capitalization of earnings method

involves capitalization of future cash flows employing the relevant rate of return (Trugman). In

most instances, Professionals employ the method in evaluating companies with stable cash flows.

On the other hand, for the Discounted Cashflow method, all cash flows inclusion of the terminal

value is discounted to present value through discount rate rather than capitalization rate. Under

DCF, the experts and professionals account for expected cash flows over a discrete period and a

terminal value at the end of the discrete period.

The asset-based approach, also known as capital approach is a method that involves

deriving the business value from the combined fair market value (FMV) of the business's net

assets. The approach usually provides a value controlling level through which an investor has the

power to liquify the company's assets. Therefore, when valuing a minority interest by cost

approach, professionals prefer employing a discount for lack of control (DLOC). Besides, the

cost approach valuation method is appropriate in assessing holding companies, distressed

entities, and asset-intensive companies that are less worth than their net values. The asset-based

approach involves adjusted net asset and book value methods (Trugman). In this case, the book
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value method derives the business value using available data from company books. The adjusted

net asset method involves the conversion of book value to fair market value and accounts

recorder and unrecorded tangibles and liabilities.

The use of the above three techniques of business valuation was triggered by the need for

investors making sales or purchases, securing financing, and adding shareholders. In this context,

valuation provides appropriate worth for a business and hence saves on overspending or

underspending. On the other hand, through evaluation, potential investors would need to decide

on sufficiency in business worth and the share value.

Works Cited

Trugman. Understanding business valuation: A practical guide to valuing small to medium-sized

businesses. John Wiley & Sons, 2016. Works Cited

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Corporate Finance Institute. "Valuation Methods - Three Main Approaches to Value a Business."

Corporate Finance Institute, Corporate Finance Institute, 1 June 2021,

corporatefinanceinstitute.com/resources/knowledge/valuation/valuation-methods/.

Accessed 30 Sept. 2021.

ICAEW. Welcome to ICAEW.com | ICAEW, 2017,

www.icaew.com/-/media/corporate/files/library/subjects/accounting-history/the-

development-of-accountancy-in-the-uk.ashx.